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The Men Who Ended Goldman’s War

Robert Khuzami at the S.E.C., left, negotiated for months with Gregory Palm at Goldman Sachs to settle a case that could define both of their careers.Credit
Chris Kleponis/Bloomberg News; Susan Walsh/Associated Press

LAST Wednesday at around 3 p.m., the Securities and Exchange Commission and Goldman Sachs settled an epic, seismic battle — one waged over whether the storied investment bank defrauded investors in a transaction that regulators said Goldman had built to self-destruct.

The final terms of the settlement were hashed out over the telephone. On one end, Gregory K. Palm, Goldman’s general counsel, agreed to the exact language his bank would use in statements about the settlement. As one of the longest-serving executives of the bank and a Goldman shareholder, Mr. Palm also had his own reputation and his personal fortune on the line.

On the other end, the S.E.C.’s director of enforcement, Robert Khuzami, was joined by his old friend and deputy, Lorin Reisner. Mr. Khuzami, a former in-house counsel at Deutsche Bank, was well-versed in the inner workings of Wall Street deal-making.

In the end, Goldman decided to steer clear of a protracted and damaging trial by paying a $550 million penalty, which the S.E.C. went out of its way to describe as the largest ever against a Wall Street firm. Goldman acknowledged that its marketing materials for the deal in question, known as Abacus, were lacking, and it agreed to greater disclosure around such transactions in the future — a concession that affects the entire financial community and could eat into some of the lush profits firms earn on complex deals engineered in the shadows.

For all of the lawyers on the phone, a court trial would have been a career-capping event. The case centered on Abacus, a mortgage deal that Goldman created in part to allow a prominent hedge fund manager, John Paulson, to bet against the housing market — something that might not pass muster with the average juror.

But, in many ways, in the years leading up to the settlement, Goldman had already been on trial. Ever since the financial crisis reached its most perilous chapter in the fall of 2008, ushering in a series of huge federal bailouts of Wall Street, Goldman’s swagger had been tested and its reputation with clients, investors, some of its own alumni and the public had been soiled.

And after the S.E.C. filed its fraud case on April 16, Goldman was forced into the court of public opinion time and again as Congressional leaders and examiners grilled its chief executive, Lloyd C. Blankfein, and its other leaders about how the firm treated its clients and how it conducted business.

The bank’s response to its critics and its legal strategy consisted largely of testy defiance and stubborn belligerence. Like a trader in a heated valuation dispute, Goldman’s legal team argued nearly to the end that it was completely in the right. It was a strategy that led other lawyers across the industry to snicker; they thought that Goldman was courting disaster by trying to win a battle of wills in today’s anti-bank environment.

But Goldman managed to give up less than some people thought it might have to; the penalty was relatively manageable for a firm that gushes money, and when the deal was announced on Thursday, the bank didn’t admit to engaging in fraud.

“After a long history of losing, this is a major victory for the S.E.C. and the enforcement division,” says Barry Ritholtz, who, as the head of Fusion IQ, a financial research firm, also oversees a closely followed financial blog, The Big Picture. “In general, it’s better for the investing public when the cop is on the beat and actually paying attention.”

For Goldman, says Mr. Ritholtz, the case has been an embarrassment and a setback.

“Look, they were the firm on Wall Street that avoided the subprime collapse, and they could have come out of this with their reputation enhanced,” he says. “Instead they came out with: ‘O.K., let’s get this right: You played fast and loose with the rules and dumped stuff on your clients and created products in order to get short? I mean, it’s harder to get sleazier than that outside a boiler room. But we don’t yet know if that has caused lasting damage to Goldman’s reputation.”

Goldman declined to comment about the settlement beyond its statement on Thursday, in which it said: “We believe that this settlement is the right outcome for our firm, our shareholders and our clients.”

MR. KHUZAMI took to the cameras when the S.E.C. sued Goldman, and early on he became the face most associated with the case. A graduate of the University of Rochester and the Boston University School of Law, he joined the United States Attorney’s Office in Manhattan in 1990.

Another lawyer — Lorin Reisner — joined the same office that year, and the two became pals. For months, they had to share a computer while they waited for their office to order more.

But Mr. Khuzami stayed much longer than Mr. Reisner — 11 years — and he rose through the ranks to eventually run a securities and commodities fraud unit for the office. He also prosecuted those responsible for the 1993 World Trade Center bombing. He left the prosecutor’s office in 2002 to join Deutsche and was tapped last year by the S.E.C.’s chairwoman, Mary Schapiro, to be the agency’s enforcement chief.

Mr. Khuzami joined the S.E.C. when its own reputation was in tatters. Analysts and legislators had castigated the agency as doing little to curb Wall Street’s excesses and to monitor questionable activities in the years before the financial crisis.

Well aware of all this, Mr. Khuzami came into the agency with priorities that included streamlining staffing and practices in enforcement, as well as formalizing procedures to encourage witnesses to come forward.

Because Deutsche had issued securities similar to those in the Goldman case, Mr. Khuzami had to recuse himself from a portion of the S.E.C.’s mortgage investigation involving Deutsche. And he called on Mr. Reisner to add muscle to many of the S.E.C. cases, especially the one involving Goldman.

Some people close to Mr. Khuzami and Mr. Reisner joke that they are like Tweedledee and Tweedledum. When Mr. Khuzami travels, Mr. Reisner runs many of the enforcement unit’s daily operations.

Mr. Reisner attracted little attention outside the S.E.C. until May, when the commission notified the court of his involvement in the Goldman case. A guessing game began within the commission on whether Mr. Khuzami himself would deliver the opening statement or delegate that to Mr. Reisner if the case went to court (which many at the S.E.C. considered unlikely).

Photo

Team members at the enforcement division of the S.E.C. are, from left, Kenneth R. Lench; Daniel M. Hawke; Cheryl J. Scarboro; Robert Khuzami, the division’s director; Thomas Sporkin; Robert Kaplan; and Lorin Reisner, the deputy director.Credit
Daniel Rosenbaum for The New York Times

For Mr. Reisner, the S.E.C. job was a second visit to the public stage. Raised in the New York suburbs by two public school teachers, he attended Brandeis University and Harvard Law School. In law school, he won both the top moot trial award for arguing a case and the top negotiation prize — a rare feat.

He clerked for the federal judge whose caseload included the high-profile insider-trading case involving Ivan Boesky. After a short stint in private practice, Mr. Reisner became an assistant United States attorney in Manhattan for the Southern District of New York, where he handled public corruption cases and a large racketeering case.

Mr. Reisner returned to the private sector in 1994, joining a New York firm, Debevoise & Plimpton. There, he carved out a specialty as a media and trademark lawyer for clients like the Gap, the N.F.L. and The New York Times Company. He also kept a hand in white-collar crime cases and worked closely with Mary Jo White, the well-regarded litigator who joined Debevoise as a partner after running the United States attorney’s office in Manhattan.

Mr. Reisner and his wife, Mimi, often hosted parties at homes on Park Avenue and in Water Mill, N.Y., and it was at one of those events about 10 years ago that Mr. Khuzami met his wife, Julie.

Former colleagues in the Southern District remember Mr. Reisner as a meticulous micromanager. In particular, they say, he spent hour upon hour preparing for cases and interviewing people who were potential cooperating witnesses.

“He’s the one I would go to for advice,” says Allen D. Applbaum, a lawyer with FTI Consulting who also shared the communal computer with Mr. Reisner when they worked together at the United States attorney’s office. “He’s not a cowboy; he would never do something reckless.”

“But he does have guts,” adds Mr. Applbaum, speaking of the Goldman lawsuit. “It takes guts to file a case like this one.”

Mr. Reisner’s friends say it nagged at him that he hadn’t stayed longer in the prosecutor’s office to do more in public service. When Mr. Khuzami offered him a job as his deputy at the S.E.C., he jumped at the chance, moving his family to Washington.

“It was the opportunity in the wake of the financial crisis to help to restore the integrity of the market and to send the message that everybody’s got to play by the same rules,” Mr. Reisner says of his decision to join the S.E.C. “We are focusing the financial markets back on principles like integrity and honesty and fair dealing.”

GREG PALM has taken Goldman’s recent travails particularly hard, say several people who know him, because he believes his firm hasn’t done anything wrong. The scrutiny Goldman has wrestled with has worn on a quiet lawyer used to and more comfortable with operating in the background, they say.

Indeed, he has been able to stay behind the scenes for almost his entire tenure at Goldman, which he joined in 1992 from Sullivan & Cromwell, a law firm that has long represented it.

Former Goldman partners who were at the firm when he joined it remember that Mr. Palm’s résumé and stellar performance at the Massachusetts Institute of Technology and Harvard Law School turned heads — even at Goldman, a company accustomed to recruiting employees with blue-chip educational and professional backgrounds.

The son of a union electrician in upstate New York, Mr. Palm attended college on a scholarship and won the National Science Foundation Fellowship award at M.I.T. He clerked for two judges, including a Supreme Court justice.

At Goldman, he works with a co-general counsel, Esta Stecher. He spends more of his time on big-picture strategy, while Ms. Stecher handles more of the nuts-and-bolts matters, according to three people with direct knowledge of Goldman’s legal department. He has long represented Goldman in negotiations with law enforcement, including during a wide-ranging investigation of conflicts in Wall Street research practices several years ago.

Back then, Mr. Palm sat across the table from Stephen M. Cutler, then director of enforcement at the S.E.C. and now the general counsel of JPMorgan Chase. Mr. Cutler said he developed tremendous respect for Mr. Palm in those negotiations.

“You might get lots of pushback from him or lots of negotiating, but it was never a cantankerous, bullying type of approach,” Mr. Cutler recalls. “It’s always very intellectual, very cerebral and intellectually honest. He’d push you on whether you were thinking using a coherent framework.”

FORMER Goldman colleagues say Mr. Palm won the admiration of many when he worked from his home in New Jersey for a few months in the late 1990s so he could care for his first wife, Marie, as she was dying from cancer. Mr. Palm later remarried, and he and his wife, Susan, moved into a home on Park Avenue.

Like many Goldman partners, Mr. Palm also poured his money into Goldman’s own investment funds, hoping for outsize returns. That came back to bite him in the fall of 2008 when the financial crisis hit. As Goldman neared the brink, Mr. Palm was caught in a financial squeeze and ran short on cash. Goldman paid him $38.3 million to buy out some of his stakes in the funds. The stakes were otherwise illiquid, but Goldman purchased them from him so he would not have to sell Goldman stock, which might have alarmed investors.

Several people who know Mr. Palm say they were shocked that he was short on cash because he was not a lavish spender and because Goldman has paid him lavishly. Goldman has given him stock and options worth $59 million since 2002, according to Equilar, an executive compensation research firm.

Appearing before a Senate committee in November 2008, just after Goldman received a $10 billion taxpayer bailout, Mr. Palm appeared relaxed and friendly, telling lawmakers that Goldman’s compensation would be down that year. “We get it,” he said emphatically.

Yet Goldman continued to pay Mr. Palm richly. In 2008, he didn’t get a cash bonus but he did receive a substantial package of options and stock when Goldman’s shares were trading near their lows; less than a year later the package was worth nearly $12 million, according to Equilar.

The upbeat demeanor that Mr. Palm displayed before Congress in 2008 would slowly disappear as the S.E.C. mounted its investigation in 2009.

After The New York Times published an article late last year about how Goldman created and marketed the Abacus deals, Mr. Palm spent weeks defending the firm to acquaintances. According to one person who spoke with him around that time, Mr. Palm appeared frustrated by the article and said that Goldman had properly informed investors in the deal that the bank might have been betting against it. “It was disclosed, it was disclosed,” he told this person.

Lucas van Praag, a Goldman spokesman, said Mr. Palm would not comment for this article. He said Mr. Palm does not recall the remarks and does not believe that he made them.

Mr. Palm’s stance didn’t change later, even as the S.E.C. came closer to filing a lawsuit. Richard Klapper, Goldman’s outside lawyer from Sullivan & Cromwell, met with Mr. Reisner of the commission just weeks before the case was filed and continued to say that Goldman did nothing wrong and that the S.E.C. was off-target, according to two people familiar with that meeting who requested anonymity because the talks were intended to be confidential.

Mr. Reisner and a spokeswoman for Mr. Klapper declined to comment on the meeting. Mr. van Praag said that the meeting was focused on an “individual” he would not name and that Goldman as a firm was not discussed.

Although the S.E.C. notified Goldman in the fall of 2009 that it was considering filing a lawsuit against the firm, Goldman’s lawyers didn’t disclose that information publicly until after the case was filed in the spring. Goldman later said that it didn’t disclose the possibility of the lawsuit earlier because it didn’t consider it to be of “material” interest to its shareholders.

As the S.E.C. got ready to file its case, it didn’t warn Goldman that it was about to do so, a move that Goldman considered to be underhanded. Officials at the commission interpreted Mr. Klapper’s earlier comments to mean that Goldman was far from agreeing to a settlement and that a filing was clearly inevitable, according to the two people involved in the settlement talks.

Mr. Palm took the unusual step of speaking on Goldman’s earnings call four days after the S.E.C. case was filed. He said that Goldman had “skin in the game” in the Abacus deal because the firm had retained a piece of it and therefore had no reason to create a deal built to implode.

A week later, a Goldman employee testified before a Senate subcommittee that Goldman had actually wanted to unload that piece of the Abacus deal but was unable to find a buyer willing to pay an attractive price.

On the day of that Senate hearing into Goldman’s conduct — an 11-hour marathon that was one of the most-watched events of the crisis — Mr. Palm was the first Goldman executive to enter the chamber.

He rushed to the chairs behind the witness stand, and like a student determined not to miss a beat on an exam, picked up the hefty book of exhibits and began poring over them. When other Goldman witnesses appeared, he sat silently behind them, his hair frayed, his lips pursed.

IF there’s one thing that associates of Mr. Reisner and Mr. Palm say again and again, it is that they steep themselves in their work. Both are used to being in control, both boast prestigious credentials, and both are formidable adversaries.

After the S.E.C. filed its case, Goldman disparaged the case publicly as meritless and questioned the commission’s assertions about basic facts in the creation of the Abacus deals.

As the case wore on, Mr. Reisner’s role evolved into an unusual one at the S.E.C. — bridging the gap between the lawyers who ran its investigation and those who would try the case in court. Mr. Reisner had also personally taken testimony from some of the witnesses in the case, and he drew on their comments in his talks with Goldman.

For his part, Mr. Palm split his time between the S.E.C. suit and all the other questions about Goldman’s conduct that were swirling around him from Congressional committees. He focused particularly on how Congressional testimony would affect Goldman’s position in the S.E.C. case and in other lawsuits, according to two people with knowledge of the situation who declined to be identified because the bank’s legal strategy was intended to be confidential.

Goldman, according to people with knowledge of the settlement talks, never focused on the scope of possible financial penalties because it believed that its coffers were flush enough to absorb a fine. Instead, it gradually shifted from a stance that involved an outright denial of any wrongdoing to a settlement with terms that the bank could call a win.

According to people familiar with the internal workings of the S.E.C., the agency’s five-member commission was split 3 to 2 in a vote about whether to accept the settlement, reflecting the same political divisions that existed at the agency about whether to file the lawsuit in the first place.

While most settlements with the S.E.C. don’t include an acknowledgment of wrongdoing, Goldman did concede a “mistake.” Still, its supporters last week said the company had scored points by not admitting to having committed a fraud. The S.E.C. saw its victory made tangible in a historic, $550 million fine and a 71-word statement that Goldman agreed to make. Goldman admitted that it had put out “incomplete information” in the Abacus deal, a “mistake” that it “regrets.” From a financial titan long convinced it was infallible, the statement appeared humbling.

How long Goldman remains humble is another matter.

“It’s become pretty clear what Goldman has become, and this settlement is an outgrowth of it,” says Charles Geisst, a finance professor at Manhattan College and author of “Collateral Damaged,” a book on the financial crisis. “But a fine is not going to bother these people, quite frankly. A fine is like passing around the church collection plate and collecting a few extra bucks for sins.

“This is unlikely to change much at all,” he adds. “I think it will be business as usual right away.

“They’ll just surround themselves with extra lawyers.”

A version of this article appears in print on July 18, 2010, on page BU1 of the New York edition with the headline: The Generals Who Ended Goldman’s War. Order Reprints|Today's Paper|Subscribe